Info + Advice for Indies

Simple, Accurate Info + Advice

What’ll it cost me to leave my W-2 job for the indie life?

Is the plunge really worth it?

In my article Taxes: Which ones and how much do I pay? I introduced the two kinds of federal taxes paid by the self-employed. Let’s use three questions sent in by my website visitors to look at specific numbers and tax amounts.

June, I have been offered a 1099 independent contractor position (and I’ve never been one before) and was wondering what taxes I will be paying. I was offered $45 per hour as a W-2 employee no benefits or $52 per hour independent contractor no benefits, which would be better? This would be a travel position, that is, living near the job during the week (paying all expenses to live) and returning home on the weekends.

Thanks.
Bob in Michigan

Hi June,

I’ve just started contracting. How do I figure out my taxes based on 35 hour $30/hr work week?

Carla, Technical Writer

Hi June,

I’m a full-time employee with vacation and benefits earning $46K/yr in the San Francisco area. (Not enough) I am thinking about jumping to a contract position that will pay $35/hour. Will my tax rate change? What if I buy a condo and become a homeowner? Will becoming a contractor be good for me or hurt me financially?

What else should I be thinking about? Thanks!

Sincerely,
Eileen

I’ll use an example to give you a handle on the closely-related questions that the three indies asked.

If Bob from Michigan as an employee earns $45 per hour for 40 hours per week for 52 weeks per year, then his wages are $93,600 per year. And if he is single, has no other income, has no medical bills, rents an apartment and so has no mortgage interest or property taxes to pay, and he gives nothing to charity and has no investment income or losses, then his federal income tax for 2012 would be $16,999. As an employee he would also have paid a little less tahn one-half of his share of FICA (that’s Social Security tax) amounting to $3,391 and one-half of his Medicare Tax, amounting to $1,357. That’s a total to the feds of $22,287. Excluding any state taxeshe’d end up with $71,313 in his pocket after taxes.

And, if Bob became an independent contractor, were paid $52 per hour his gross self-employed income would be $108,160. And, with no business expenses and if all the conditions were the same as when he was an employee then his federal income tax on $108,160 would be $18,878 and his 100% payment for self-employment tax – remember that’s the self-employed’s combined Social Security and Medicare tax — would be $13,285. That’s a total to the feds of $32,163. And in this case, excluding any state taxes,he’d end up with $75,997 in his pocket after taxes.

Now although the above example gives an accurate accounting of income and taxes it is not a realistic picture because there are many financial variables in the lives of most people.

If Bob earned the same gross income — $93,600 – as an employee and as a self-employed and if he had, let’s say, $5,000 deductible travel expenses applicable to each, there would be a big difference in his tax liability.

As an employee his business expenses do not come over the minimum required to have an impact on his taxes. However, as a self-employed the business expenses are deductible from the first dollar of expense. The $5,000 in travel expenses would reduce his federal taxes by $1,916.

Now I’ll give you an example of how a faulty question leads to a faulty answer. You see in the Bob from Michigan example I had to make many assumptions to come up with an answer that made sense.

All three indies omitted much of the important information needed to determine tax liability or even % of tax change.

Bob and Carla asked about taxes for an indie based on hourly compensation. They left out things such as:

An approximate amount of business expenses against the hourly rate

An approximate total of personal deductions of items such as mortgage interest, medical, charitable contributions

Whether married or not

At $30 per hour net income Carla can plan on $9 to $12 per hour going to taxes. Read Taxes: Which ones and how much do I pay? to see why.

Bob says that neither work arrangement offers fringe benefits, but as an employee he is eligible for workers compensation and unemployment benefits, neither of which are available to a freelancer.

Eileen in San Francisco is looking at giving up all her benefits for the freelance life. She asks whether “becoming a contractor would be good for me or hurt me financially?” She didn’t say what benefits she’d be giving up. A turkey at Christmas? Very different than complete medical coverage. Right?

!! What you as a self-employed, or budding indie, need to consider is that all of your finances are linked. Investment earnings, married with children, supporting Grandma, good recordkeeping – all have an impact on your total tax and all effect how much your freelance income is taxed !!

Ask carefully-thought-out questions of the right people before, to quote Eileen, “jumping to a contract position.”

2 Responses to “What’ll it cost me to leave my W-2 job for the indie life?”

Hi June, I’m thinking about venturing into becoming an online content writer. I have done some research into websites that not only pay beginner writers but will continuously find gigs for them to help them hone their skills. I haven’t researched far enough into it yet but I believe many of these companies pay through PayPal. What’s the best way to keep records of this because I have never been an indie before? Currently I have a W-2 job with benefits, I’m single, and I have no kids. If I decide to become an online writer, whatever money I may make with this venture starting out even if it is a small amount let’s say $200 will I still need to fill out a 1099 at the end of the year and keep records? I am looking to eventually quit my day job possibly with this venture and I wanted to get your advice before I make a move.

Whoa, Rickey. That’s a lot of info you need. Either start by reading everything on my site. Or … get my two books. Inexpensive, and you’ll learn all the basics you need and in a more organized way that going through my site page by 100s of pages. Books are here:

Specific answer: YOU don’t file or fill out a 1099, the person or company paying you files a 1099 if you were paid $600 or more by the PAYER. You must still claim that $200 in income. Although, when you know a little more, no, a lot more, about record-keeping you’ll likely find you have a loss against that $200 income. That loss may be subtracted from your W2 income and you’ll save some money in taxes.

Pushy advice: If you are going to do this full time — great! — and definitely read my books or my site.

I just purchased your book Self Employed Tax Solutions, and let me start by saying this is the first time I have written an email to an author. I’m only in the third chapter and am so happy about the …Dean Iodice

I really enjoyed reading your book. So many other [tax books] were too technical, very lengthy and downright boring. You injected your sense of humor and put everything in layman’s terms. I refer to y…Ephraim Schum

I read Self-employed Tax Solutions from cover to cover in about 3 days (I finished it today), and found it engaging and well written. That’s high praise for a book on taxes. I’ve read other tax books ……Paul Plamondon

I purchased a couple of books re: self employment taxes. I like yours (Self-employed Tax Solutions) because it’s written in plain language. The JK Lasser book (Small Business Taxes) appears to be writ…Linda Gordon

I recently bought your book, and wanted to tell you what you already know – it’s terrific. So many great common-sense features. In addition to my “indie” business, I’ve also been a tax preparer for an…James M. Beidler